Cullen/Frost Bankers, Inc. (NYSE: CFR) — Q3 2020 Form 10-Q
Business context and reporting period
Unaudited results for the quarter and nine months ended September 30, 2020. Cullen/Frost is a Texas-based financial holding company whose principal businesses are banking and wealth management. Comparisons below are with the corresponding 2019 periods unless otherwise noted; balance-sheet comparisons are with December 31, 2019. Amounts are in U.S. dollars.
Financial performance and condition
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $243.4m | $253.0m | $733.8m | $752.9m |
| Credit loss expense | $20.3m | $8.0m | $227.5m | $25.4m |
| Non-interest income | $83.6m | $89.2m | $374.1m | $268.6m |
| Non-interest expense | $202.2m | $208.9m | $626.0m | $613.9m |
| Net income | $95.1m | $111.8m | $242.9m | $339.9m |
| Diluted earnings per share | $1.50 | $1.73 | $3.71 | $5.24 |
| Taxable-equivalent net interest margin | 2.95% | 3.76% | 3.20% | 3.80% |
- Profitability and revenue: Net income available to common shareholders was $95.1m in Q3, down 13.4%, and $235.4m for nine months, down 29.5%. Nine-month non-interest income included a $109.0m securities-sale gain; excluding that gain, it declined 1.2% year over year. The nine-month effective tax rate was 4.5%, including a one-time charitable-trust-related tax benefit in Q2.
- Cash flow: Nine-month operating cash flow was $475.1m, investing cash outflow $2.57bn, and financing cash inflow $5.48bn. Cash and cash equivalents increased $3.39bn to $7.18bn.
- Balance sheet and liquidity: Total assets were $40.10bn, up from $34.03bn at year-end 2019. Deposits rose to $33.50bn from $27.64bn; non-interest-bearing demand deposits were $14.85bn. Loans were $18.22bn, up from $14.75bn, including $3.23bn of PPP loans. The company reported $6.6bn in interest-bearing deposits at the Federal Reserve, approximately $2.7bn of FHLB borrowing capacity and $8.1bn of unencumbered securities.
- Credit and asset quality: The loan allowance was $263.5m (1.45% of loans; 1.76% excluding PPP), versus $132.2m at year-end. Nine-month net charge-offs were $89.9m, including $68.8m in energy loans. Non-performing assets were $96.4m, down from $109.5m at year-end, but accruing past-due loans increased to $132.6m from $58.2m. Potential problem loans rose to $126.0m from $46.8m.
- Debt and capital: At September 30, federal funds purchased and repurchase agreements were $1.61bn; subordinated notes were $99.0m and junior subordinated debentures $136.3m. Regulatory capital ratios exceeded well-capitalized thresholds: Cullen/Frost CET1 12.71%, total capital 14.69%, and leverage 7.85%. The company redeemed its $150m Series A preferred stock in March. Common dividends were $0.71 per share in Q3.
Material changes versus prior periods
- Lower market rates reduced asset yields and compressed taxable-equivalent net interest margin by 81 basis points in Q3 and 60 basis points for the nine-month period. The decline in funding costs partly offset reduced loan and deposit yields.
- The $3.23bn of PPP lending drove much of reported loan growth. Excluding PPP, loans were up $246.6m from year-end but down $341.4m from March 31.
- Credit loss expense increased sharply amid CECL adoption, COVID-19 uncertainty and oil-price volatility. CECL adoption on January 1 reduced retained earnings by $29.3m after tax; prior-year credit expense used the incurred-loss method, limiting direct comparability.
- Expense trends were mixed: nine-month non-interest expense rose 2.0%, with higher technology and occupancy costs partly offset by lower employee benefits and other expenses.
Outlook, commentary, risks and unusual items
- Management said the pandemic’s ultimate adverse impact could not be reliably estimated and was expected to remain material. It highlighted borrower stress, credit deterioration and possible further defaults, especially in energy, retail/strip centers, hotels, restaurants, entertainment and commercial real estate.
- Management expects low rates to continue pressuring net interest income and margin; the Federal Reserve’s September 2020 indication was that rates could remain near current levels through 2023. PPP fee recognition was expected to support near-term results; approximately $58.5m of net deferred PPP processing fees remained to be recognized over the loans’ remaining terms.
- About 300 loans totaling $157.2m were under COVID-related payment deferrals at September 30. Such qualifying short-term deferrals were generally not classified as past due, non-accrual or troubled debt restructurings.
- CECL estimates depend on forecasts and management judgments. The allowance included additional energy and pandemic-sensitive industry adjustments; management reported a $44.4m borrowing-base deficiency on energy production loans under its internal oil-price assumptions.
- Unusual earnings items included the $109.0m securities gain, $6.0m gain on Treasury put options, the one-time Q2 tax benefit and the preferred-stock redemption charge. Legal matters included PPP agent-fee class actions; management stated it did not expect existing matters to materially harm the financial statements and said it believed the claims were without merit.
- No quantified full-year earnings or revenue guidance was provided. Other risks include further economic weakness, oil-price volatility, rate movements, liquidity demands, operational/cybersecurity risks and regulatory or litigation exposure. Disclosure controls were reported effective.
Important facts for investors to verify
- Whether CECL assumptions and the $263.5m loan allowance remain adequate as pandemic conditions, unemployment, commercial real estate performance and oil prices evolve.
- Energy and commercial real estate exposures, including charge-offs, criticized/classified loans, potential problem credits and the status of payment deferrals.
- PPP forgiveness timing, SBA repayment/guarantee performance and the pace at which remaining deferred fees are recognized.
- Underlying earnings excluding securities-sale and option gains, the discrete tax benefit and preferred-stock redemption effects.
- Deposit stability, contingent liquidity sources, dividend capacity and capital ratios as lending and credit losses change.